CAT T10-Managing Receivables

This time, I will summarise some of the managing receivables issues and also introduce a bit of law issues related to contract. Offering credit can increase greatly the amount of sales a business makes. If a significant percentage of sales are credit sales, then receivables may represent a significant asset of the business. However if these customers are slow to pay (or do not pay at all), a business can lose a significant amount of money through assets being in the form of debt rather than cash balances which are earning interest. Because of the importance of receivables as an asset, many businesses operate a credit control function to assess whether to grant credit, to monitor credit and to take the necessary action against slow payers.

Just as there is a relationship between offering credit and securing sales, there also has to be a suitable working relationship between credit control personnel and sales and marketing staff. They will have a credit control policy for guidance in credit issues. Inside the credit control policy, they would set up the things to do before, during and after the credit period. During and after the credit period, the things that will be done are typically monitoring the receivables and also collecting debts which had discussed in the earlier articles. I am concern with the issues before the credit period.

Before the credit period, credit controller needs to make decision whether or not to grant credit and how much credit to offer to a certain customer, this will include assessing creditworthiness (also discussed in earlier article), devise suitable credit terms and also offering early settlement discount. Credit terms that will be offer depend on many factors such as profit required, nature of the business, competitors' credit terms offered, relation with customers, credit terms obtained from own suppliers and more. The terms must be simple to understand and easily enforceable. The credit controller may also wish to offer early settlement discount as it has benefits such as reduce cost of providing credit and chasing late payers, improve liquidity position, customers attracted to make larger orders and fewer bad debts. But the early settlement discount will only offer if the cost of offering the discount is less than company's cost of capital.

Percentage cost of early settlement discount=[(100/100 - d)^(365/t) - 1]%

d=the discount offered

t=reduction in the payment period necessary to obtain the early settlement discount

For example, Joblot Co has annual sales of $12000000 and a receivables' collection period of two months (sixty days). Management are considering the introduction of an early settlement discunt of 2%, which if introduced, is expected to reduce the receivables' collection period to one month (thirty days). Joblot Co can invest surplus funds to achieve a return of 30% (the company's cost of capital). Advise the management of Joblot Co as to whether or not they should introduce the settlement discount.

Answer:

Cost of early settlement discount= (100/100 - 2)^(365/30) - 1 = 27.86%

This cost is less than the company's cost of capital (30%) and therefore the settlement discount should be offered.

The credit controller's job often involves the law, especially when enforcing collection. The sale of goods and/or services for cash is a type of contract, and the credit controller's job is to ensure that the customer keeps his or her side of the contract. A contract is an agreement which legally binds the parties (ie those entering into the agreement). The key elements of contract are as follow:

Form - Agreement in writing. Most contracts do not need to be in any strict form except sale or purchase of land must be in writing under UK law. Consumer credit agreements must also be in writing.

Legal intention - Both parties must have intention to create legal relations.

Offer - A firm proposal to give or do something. An offer can be made expressly or by implication, and it does not need to be in writing.

Acceptance - Unconditional agreement to all the terms of the offer.

Consideration - It is what a person (the promisee) must give in exchange for what has been promised to him. For example, X agrees to buy goods from Y for an agreed consideration (price). If X fails to deliver the supply and Y is forced to buy these elsewhere at a higher price, then Y can sue X for the difference in price provided all the elements of a valid contract are present.

In order to minisie losses and manage customers more effectively, specific terms and conditions that can be included in the contracts are as follow:

Length of free credit - Each invoice should also clearly state this credit period. If the customer then breaks this agreement, they are in breach of contract and the relevant remedies can be pursued.

Interest charged on late payments - As with the credit period, the amount of interest to be charged should also be printed on each invoice, as a reminder to the customer that you mean business.

Retention of title clause - This clause states that the buyer does not obtain ownership of the goods unless and until payment is made. Thus if the buyer goes out of business before paying for the goods, the supplier can retrieve them.

In conclusion, managing receivables is about placing enough control on the credit period which is before, during and after the credit period. You need to know about the contract because it is an important document before and after the credit period. Once again, summarise as before credit period (assess creditworthiness, devise credit terms, offer early settlement discount, make contract), during credit period (monitor receivables) and after credit period (pursue due debts, chase late payers and sue if there is breach of contract). These are the knowledge that you have to know about managing receivables.